Tackling Purchased Services

Controlling costs is critical to the bottom line, and services represent a significant opportunity to do so.

Regardless of size, location or performance, healthcare organizations are leaving no stone unturned in their efforts to reduce the cost of providing services while increasing efficiency. New government initiatives mandating improved quality and outcomes – such as quality-based payment or reimbursement know as P4P, or pay for performance – are adding to the pressure.

In an effort to operate as efficiently as possible, some providers are starting to turn their attention to purchased services as a potentially untapped area of cost reduction.

Purchased services are defined as “non-supply” spending that impacts a provider’s operating margin. (Operating margin precedes net margin. Expressed as an equation, net margin = operating margin + investments and charitable contributions. In many cases, healthcare organizations may actually be losing money at their operating line, but are able to offset the loss with revenue from their investments or charitable activities.)

Historically, hospitals and IDNs have attempted to reduce the cost of the services they provide by reducing the cost of the supplies used to provide those services. In this country, providers drive approximately $150 billion of supply spending through their GPOs each year. However, what many of these organizations don’t realize is that the amount of money they spend annually on purchased services can be equal to, or just slightly less, than what they spend on supplies.

The challenges
So if spending on purchased services rivals that of supplies, why haven’t providers attempted to capitalize on such a huge opportunity to reduce costs and improve their operating margins? There are several reasons.

Unlike supplies, which are generally ordered using catalogs, services are purchased throughout the facility. And rather than being delivered to a loading dock under the supervision of materials management, services enter every access point of the organization, and, in some cases, may actually occur outside of the building.

Providers of services are many and diverse. They may include national suppliers as well as local “mom & pop” companies. A healthcare facility may use a national provider for food service, and a local provider for lawn or housekeeping services.

Services are provided; they’re not “widgets,” like supplies. There may not be a catalog or price guide from which the associated costs are derived. Also, services tend to reflect the unique requirements of the specific healthcare organization, and this affects their cost.

Because benchmarks on services costs are not readily available, providers have difficulty determining whether or not they are spending too much or too little. It also inhibits their ability to negotiate appropriate costs.

The opportunity
The good news is that hospitals and IDNs that have taken on the challenge of identifying and addressing their spending on services can reduce their costs up to 15 percent. This reduction can be significant and, in some cases, immediate. In fact, an organization spending $30 to $40 million on services could see cost reductions of $4.5 to $6 million.

Unlike supplies, where the goal is to reduce the cost of items yet to be bought, reducing spending on services means that dollars never leave the bank. This can very important to a facility attempting to conserve or manage its cash. If an organization has an operating margin of 2 percent, then for every dollar earned, 2 cents goes into the bank account. If that organization avoids spending a dollar for purchased services, it keeps a solid dollar in its account.

How to approach the task
Step One to target spending on services is to create a team and develop a plan. When assembling the team, consider including an executive sponsor with overall accountability to Finance for achievement of the reduction goals. (Spending on services is typically associated with department directors, and they may or may not be open to changes required to implement the cost reduction plan. An executive sponsor could be instrumental in overcoming departmental resistance.) Also, the organization’s group purchasing organization may offer staff with expertise in assisting with various aspects of the plan.

Once the team is assembled, work can begin on analyzing spending on purchased services. An analysis of accounts payable information can help the team categorize services, identify suppliers and tally the amount of money spent. Benchmarking information can help indicate whether or not the facility is spending too much. Again, such information can be difficult to find; GPOs may be able to provide some assistance.

Once total spending on purchased services has been assessed, the team can create a target list of opportunity areas for cost reduction. Start with what’s achievable and save the more difficult areas for later. Also, keep in mind that, unlike supplies, services can be complex and their actual cost can be deceiving. For example, spending on food service includes not only the food, but the labor associated with its preparation and delivery, and possibly the equipment to prepare it. A bundled fee for food service may appear costly, but in reality, it could be more cost effective than paying separately for the various components.
Reducing spending on purchased services will not be easy. However, the impact of a successful spend reduction project provides immediate benefit to the organization. Controlling costs is critical to the bottom line, and services represent a significant opportunity. In fact, reducing the expense of purchased services is like putting cash in the bank. It is the foundation of a healthcare organization’s fiscal health and a major contributor to cash flow.

Nik Fincher is vice president of purchased services sales and capital for VHA Inc. He brings more than 30 years of experience as a clinician, RIS/PACS operations/implementation manager, medical equipment planner and consultant.